Investors in Electronic Arts (NASDAQ:EA) are having a fantastic year -- shares of the video game publisher are up more than 86% in 2014, greatly outperforming the broader S&P 500. Rapid adoption of the latest video game consoles seems to have driven demand for Electronic Arts' games.
Despite its strong out-performance, Electronic Arts could be poised for a decline. Below are three scenarios that, should they play out, would likely devastate Electronic Arts' shares. It's important to note that there's no guarantee Electronic Arts' stock will fall -- a broad market rally could always propel shares -- but investors in the video game giant would not welcome the following scenarios.
Electronic Arts' core business is still built around its PC and console titles -- key franchises such as Battlefield, Madden, and Fifa remain the significant drivers of Electronic Arts' financials. But the company has diversified into mobile games, branching out with free-to-play titles for iOS and Android devices, aimed primarily at more casual gamers. The Simpsons: Tapped Out and Plants vs Zombies 2 are among Electronic Arts' most notable mobile titles.
On an adjusted basis, Electronic Arts' mobile games brought in about 10% of the company's revenue last quarter. In comparison, Electronic Arts' Xbox One and PlayStation 4 games brought in about 35%.
Electronic Arts' console business is far more established -- investors can be reasonably confident that the latest Madden and Battlefield installments will sell to a large base of entrenched fans. Mobile, however, remains much more speculative. Other video game makers, including Electronic Arts' chief rival Activison-Blizzard, have taken a more cautious approach, noting that the long-term success of the mobile business model is largely unproven.
Other firms, including Zynga and Angry Birds-maker Rovio, have been devastated by rapid shifts in the market, and though it hasn't failed, investors remain highly suspicious of King Digital. Electronic Arts' mobile games could always suffer a similar fate. Although the business wouldn't be completely devastated by a downturn in mobile, the stock could see a sell-off.
Upcoming games receive poor reviews
As a video game publisher, Electronic Arts lives and dies by the success of its games -- if its games don't sell, the company suffers. Critical reception is not perfect, but is a fairly reliable indicator of success -- some of the best-selling video games of all-time have also been some of the most favorably reviewed. (Last year's Grand Theft Auto 5, which sold more than 34 million copies, received an impressive 97 on review aggregator Metacritic; Activision-Blizzard saw its shares sell off when its much anticipated sci-fi shooter Destiny received a relatively modest 76.)
Most of the games Electronic Arts released in 2014 have been reviewed well, including, most recently, Dragon Age: Inquisition, which may receive many "Game of the Year" nods from video game publications.
But if that trend unravels -- if Electronic Arts' upcoming games prove the bane of critics -- shares could correct. In addition to its annual sports titles, investors should keep a close eye on 2015's Battlefield: Hardline and Star Wars: Battlefront.
Its business is upended by a shifting industry landscape
Lastly, and perhaps most notably, Electronic Arts could suffer if management fails to react to what has become a rapidly shifting video game landscape. To its credit, Electronic Arts' management team has been proactive, pushing revolutionary new services like EA Access. But perhaps more so than at any other time in its history, the video game market is experiencing significant upheaval.
Mobile, free-to-play gaming has been a revolutionary force, but may still be in its early days. New, cheaper devices -- like the Fire TV and Nexus Player -- extend mobile gaming to the living room. Radical new technology, such as the Oculus Rift virtual reality headset, Project Morpheus, and Gear VR, stand to completely revolutionize the industry.
Of course, all these changes could present a terrific opportunity for Electronic Arts -- the future of the industry looks bright -- but invite newer, nimbler competitors to enter the space.
Although Electronic Arts appears to be firing on all cylinders, there's some evidence that it may not be well-suited to a new gaming environment. Earlier this month, it cancelled Dawngate, its upcoming free-to-play MOBA -- a relatively new sort of video game that has generated hundreds of millions of dollars for rival publishers. Dawngate would've been a fairly dramatic departure from Electronic Arts' core shooter and sports titles, and if successful, may have become a billion dollar franchise.
It doesn't have to hit on every new fad, but if Electronic Arts cannot adapt to new trends, its shareholders could suffer.
Sam Mattera owns shares of Activision Blizzard. The Motley Fool recommends Activision Blizzard and Apple. The Motley Fool owns shares of Activision Blizzard and Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.